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International Oil & Gas Exploration, Risk-OFF, Zodiac Exploration Risk-ON!

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Zodiac Exploration Inc. [ZEX.V & ZDEXF]
Market Cap. = ~C$29mm, Debt= $0, Cash= $17mm, (~$0.05 per share) EV= ~C$15mm

The following article is well done and one of many that clearly point to Oil & Gas majors retrenching from high risk, high cap-ex, long-lead time projects in dangerous regions of the world. Consider ultra-deep, offshore Africa for example. Exploration projects can cost $10 billion and take 10 years before first oil. Suddenly, onshore risks in Southern California don’t seem so daunting…..

Majors face resource nationalism, (including expropriation of assets) uncertain tax and royalty regimes, local community opposition and even kidnappings / piracy in some cases. By comparison, in southern California, majors face very challenging geological conditions and one of the toughest environmental / political arenas in the U.S. Which poison will majors choose, offshore Africa or California? Answer: BOTH.

That’s right, major Oil & Gas producers have little choice but to pursue virtually all hydrocarbon leads. The number of large oil discoveries has been declining for decades. Most monster oil fields are past their peaks, yet global demand keeps rising by 2%-3% each and every year. That’s why the Oil Shale revolution in the U.S., most notably in North Dakota’s Bakken and South Texas’ Eagle Ford formations, is so incredibly important. While these basins are reaching maturity in terms of prime property being locked up, a far larger oil shale bonanza remains virtually untapped. Southern California’s Monterey shale is twice the size of BOTH the Bakken and the Eagle Ford COMBINED!

So far, Occidental Petroleum, (OXY) has staked the most prominent claim, but Exxon and Royal Dutch Shell, through a private company named Aera Energy LLC and Hess are active in the area as well. Chevron, Plains Exploration, Venoco Inc, Chesapeake Energy, Linn Energy and others are also involved.

A Monterey Shale, pure-play junior named Zodiac Exploration has been developing its roughly 72,000 net acres since early 2009. Having invested $85 million, Zodiac may offer the single-best, yet least well known, opportunity to play the blue-sky potential of the Monterey. Zodiac has $17 million in cash, zero debt and tax pools with an estimated NPV of $15 million, for a total of approximately 10c/share. Yet, the stock is trading at just 8c/share.

Please see these informative and compelling articles on Zodiac.

International Oil and Gas Exploration Investment Risk-Off
August 12, 2013 by John Clarke

Risk-on, risk-off (RoRo) investing refers to the process where investors move to perceived higher risk investments for potentially higher yields and then reverse that strategy by moving back again to lower yielding investments which are perceived to have lower risk. RoRo investing behaviour frequently mimics global markets, where perceived low financial risk encourages investors to take more risk (risk-on situation), and periods of perceived higher financial risk cause investors to take less risk (risk-off situation). Thus, in the fallout period following the 2008/2009 financial crisis, switching between high risk and low risk investments occurred more frequently and in greater volumes, with investors demonstrating herd-like behaviour depending on the perceived risk environment.

Even though Quantitative Easing (QE), by the U.S. and others has artificially depressed yields on traditional safe haven investments such as treasuries and gilts, the anticipated movement towards riskier investments failed, leaving “mountains of cash on the sidelines” as investment flowed to the relatively safe havens of corporate bonds and dividends offered by established companies with strong cash flow and minimal debt. Small cap exploration companies in the resource sectors got crushed, idea generation couldn’t sell prospects, and capital markets were closed to fund escalating exploration and development costs.

Oil is Found in the Minds of Men and Women

The emergence of small, independent, frontier oil and gas exploration companies in the first decade of the 21st century was typified by a strategy of identifying and accessing large equity positions in frontier or underexplored hydrocarbon provinces. Value was then added through the early stages of exploration by securing partners to fund back costs, validate assets, diversify risk and provide capital (often through a promote) to appraise and develop discoveries. The ability to leverage exploration skills and exposure to frontier plays was a key factor in the rise of new ideas to be farmed out to the Majors and NOCs at some point in the Exploration and Development cycle. Companies such as Kosmos and Tullow successfully generated new plays in several parts of the world and were able to farm out to the likes of Total, Shell, and CNOOC etc.

However, since 2010, many smaller companies have experienced a collapse in their share prices, as drilling results have disappointed and the majors have sat on the sidelines, knowing they can wait until reserves are established, or the leases forfeited for failure to fund commitments, rather than committing to high risk exploration exposure. A slew of junior Canadian companies were attracted to emerging frontier plays, with an emphasis on the West Africa Transform Margin (Morocco to Namibia) and East Africa (onshore and offshore Kenya to Mozambique).

Unable to raise funds for expensive drilling or to farm out at early stage, almost all are forced to play the “Closology Strategy” where successful drilling results by others can promote the perceived value of their own exploration concessions. By no means is this situation limited to Canadian companies, as there are many UK-listed comparables suffering the same situation in the Risk-Off environment.

One such example is Chariot, which raised approx. $200mm in 2008 in listing onto the AIM exchange. Chariot has several concessions in Namibia and one in Mauritania, and just announced a farm-out on its C19 block in Mauritania to Cairn Energy, another proven exploration company sharing Chariot’s objective of “creating transformational value for stakeholders through the discovery of material accumulations of hydrocarbons”.

The precipitous collapse in CHAR’s share price in September, 2012 occurred on the news of a dry hole at its Kabeljou-1 well in Namibia, but the partnership with Cairn will put needed cash into the treasury and renew investor interest into the drilling event, expected in the first half of 2014. In addition, the Brazilian company HRT, has now spudded the Moosehead well, its third and final well of its Namibia exploration campaign. The Moosehead well, in the Orange basin, is targeting carbonate reservoirs with the potential for as much as 5bn barrels of oil, and again any success should rub off on adjacent players, including Chariot.

A small Canadian company, Alberta Oilsands Inc., is also hoping for success offshore Namibia! AOS has an 85% net interest in two blocks adjacent to HRT in the Orange Basin, and will be looking closely at the progress of the Moosehead well over the next 50 days (results will be in hand before the end of September), hoping that proximity to a potential resource of 5bn barrels will promote the valuation of their concessions. Moosehead has been risked with a 25% geologic chance of success, and follows two other unsuccessful wells drilled by HRT. To its benefit, AOS is not a one-trick pony, and has numerous exploration opportunities in several countries in addition to Oil Sands assets in Alberta, and thus Namibia is not the only driver.

Is Risk-Off Sentiment a Threat to Junior Explorers?

Are investors in a risk-off market willing to buy into AOS or other junior explorers, knowing that the odds of success are almost 4 to 1 against? Even if Moosehead hits, what are the odds that the AOS prospect will work? It’s a truism that the stock market is a gamble and works off perceived risk and reward, but for the Oil and Gas industry exploration has always been the catalyst for huge rewards. New frontier discoveries are increasingly expensive (deep water/remote) to find and develop, and eventually require enormous capital to reach production.

As capital for high risk exploration appears to have dried up, we wonder how the junior companies will survive the current risk-off environment and how this will affect the exploration-driven model that has been successful in finding the bulk of new reserves in the past decade! The emergence of the oil and gas resource plays has also acted as a game changer, especially in North America, where reserves and production can be added with much lower risk, but with correspondingly lower rewards. In the fallout of the great recession, we expect a sustained risk-off sentiment to continue for some time, which may not be good news for junior oil and gas exploration companies.


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